One of the primary reasons for the recent advance in stock prices has been that economic data have been surprisingly positive. Additionally, central banks around the world (including the US Federal Reserve) have remained committed to retaining exceptionally accommodative monetary policies.

There are certainly some significant downside risks that investors should remain aware of, including rising oil and gasoline prices that have been exacerbated by escalating geopolitical tensions. Additionally, we have seen some continuing progress regarding the ongoing debt crisis in Europe and while the risks of chaotic defaults seem less today than they were in the middle of 2011, political developments could trigger some setbacks.

In any case, however, we believe that the macroeconomic and policy backdrop remain broadly supportive of risk assets. In the United States, we expect the labor market to continue to improve as the year progresses and even the long-beleaguered housing market has been showing increasing signs of life. Recent comments from Fed Chairman Ben Bernanke indicate that the central bank remains concerned about economic risks and the Fed has made it very clear that its desire is to keep interest rates at historic lows for the foreseeable future. At this point, we believe that the odds for a new round of quantitative easing (i.e., QE3) remain very low given the positive trend of leading employment and economic indicators.

One wildcard that has the potential to disrupt our generally positive outlook is the US political situation. The United States faces some enormous economic, tax policy and debt-related issues that need to be resolved by the end of 2012, but it is becoming increasingly clear that little or no action is likely to be taken until after the November elections. There appears to be a general consensus that a lame duck session of Congress in December will become the venue for cobbling together some new economic and tax policies, but there is no guarantee that Congress will be able to act in time to write and pass legislation.

Should Congress fail to act, we believe there would be significant negative effects for the US economy and financial markets. The consensus among economists is that if nothing is done, higher tax rates and sharp spending cuts would shave between 3% and 4% off of the pace of US economic growth, which could trigger a high probability of a recession.

Our overall view about the markets is that improvements in the global economic outlook, continued easy financial conditions and slowly improving investor risk appetites are all reasons that stock prices should continue to crawl higher.

Markets have, however, paused somewhat in their rally over the last several weeks. To a large extent, this can be attributed to the fact that prices had risen so far so quickly and we have been saying for some time that markets were overdue for a period of consolidation or correction, but it is also important to emphasize that we believe we will need to see further evidence of economic improvement for gains to continue. We continue to believe that stocks are headed higher from here and do not believe that we have seen the market highs for 2012 yet, but we would caution that the pace of gains is likely to be slower and more uneven than they were during the first quarter.

Thank you for your continued confidence in Martone Capital Management. 

We welcome your comments and questions.

William A. Martone - President CLU, ChFC

Michael C. Martone - Registered Principal

www.martonecapital.com

William Martone is President and Senior Portfolio Manager of Martone Capital Management, Inc., which was founded in 1994. Bill has almost 40 years of experience in the financial services industry and manages portfolios for both individual investors and pension funds using multiple investment strategies. Bill is a Chartered Financial Consultant, Chartered Life Underwriter, and New York State Registered Investment Advisor. He is frequently quoted in the Westchester Journal Business News as well as other publications. Martone Capital Management was featured on CNNfn.